BBH Municipal Fixed Income Quarterly Strategy Update – 2Q 2022

June 30, 2022
Portfolio Manager, Gregory Steier, provides an analysis of the investment environment and most recent quarter-end results of the Municipal Fixed Income strategy.

Nothing Else Matters

Financial markets struggled again during the second quarter with both stocks and bonds falling sharply as the Federal Reserve Board (“the Fed”) stepped up its efforts to fight inflation. Despite a formal mandate to promote full employment and a tacit mandate to protect financial system stability, nothing else matters more today for the Fed than bringing down inflation. The consequences of the 40-year, record-high, U.S. inflation on markets have been severe, with returns deeply negative, erasing trillions of dollars of wealth in the market downturn. The impact on household budgets has also been severe, as wage growth has not kept pace with relentless price pressures.

In the bond market, we have a general rule of thumb that states what’s good for past performance is often detrimental for future performance. This was very much the case entering 2022, and it is a primary reason why municipal bonds provided little shelter to this year’s bear market. Valuations ended last year at historically expensive levels and, as they normalized, municipals struggled. The silver lining to this rule is that what’s bad for past performance is often beneficial for future results. The challenges we have faced this year have also generated significant opportunities.

For the last couple of years, we have dealt with an acute lack of yield in the bond market as investors stretched into lower-rated credits and longer maturities to earn higher investment income. Today, with market valuations near levels last seen following the Global Financial Crisis (GFC), investors no longer need to chase yield. Despite much more attractive valuations, market sentiment remains decidedly negative, driving a record-sized outflow cycle. Rather than leaning in and taking advantage of market opportunities, many municipal investors have decided that nothing else matters more than waiting out the storm by holding cash.

Last year, as valuations became gradually more expensive, municipal investors followed their hearts and herded into mutual funds and Exchange-Traded-Funds (ETFs), driving record inflows. The sentiment was so uniformly positive that there were only two days in which municipal investors, in aggregate, tried to sell more than $1 billion of bonds. Municipal investors are still following their hearts, but this year they are selling. By the middle of June, we had already broken the full-year record for days with bid lists over $1 billion. The final tally for billion-dollar selling days for the first half of the year was 86, breaking the 2018 full-year record of 76 set during the Fed’s last tightening cycle (see Exhibit I).

Exhibit I: Trading Days with Bid-Wanted Volume over $1 Billion is a bar graph that depicts years 2000-2022 annually vs. number of days in which this event occurred.

For the quarter, the yield curve steepened with short maturity yields up 20 basis points1, while intermediate and long maturity yields increased 60 to 80 basis points. This, along with wider credit spreads, drove negative municipal index returns. In addition, intermediate and full maturity municipal indexes fell 0.8% and 2.9%, extending this year’s losses to -5.6% and -9.0%, respectively. With the overhang of heavy bid lists all year, municipal trading liquidity has been strained, placing a premium on generic high-grade 5% coupon bonds. Our portfolios generally performed in-line with their benchmarks for the quarter. The higher quality orientation of our portfolios has helped, but our housing authority exposure has been among the worst performing sectors. Also, we have been surprised that in a year of rapidly increasing Fed tightening expectations, our floating-rate notes would perform so poorly. Year-to-date we have leaned into both of those areas, looking to capitalize on historically wide spreads.

Despite its intensity, we would not characterize this year’s selling pressure as a crisis. Unlike the widespread credit fears of early-2020, most municipal issuers are in better shape today than they were pre-pandemic. In many respects, 2021 was a record year and we expect it to serve as the high-water mark for governmental revenues over the next few years. However, today’s high inflation represents a challenge to credit. So far, most governments have shrugged off the inflationary threat, courtesy of record federal aid and rainy-day fund balances. Ironically, this federal aid has been a major cause of the inflation we are experiencing today.

We view inflation as a regressive tax, which disproportionately harms low and middle-income households. Several states have utilized their strong positions to help shelter taxpayers from ever growing costs. A handful of states have lowered income tax brackets, while others have implemented gas tax holidays. Some governments also plan to expand social spending as more Americans struggle to meet their basic needs (see Exhibit II). While governments can afford to be generous in the near term, our expectation is that, should inflation persist, it will slowly erode municipal finances over time, reducing future generosity. This leads to a classic tug of war between a government’s responsibility to its citizens and its responsibility to its creditors.

Exhibit II: Change in State and Local Government Revenue is a multi-line graph depicting years 2011-2021 annually, vs. Y-O-Y% change in the 3 subcategories of property taxes, income taxes, and sales taxes. The data shows a large increase for 2021 in all three revenue sources (property taxes, incomes taxes, sales taxes).

The Fed’s actions to combat inflation will leave a meaningful impact on credit. With higher borrowing rates, rising labor costs, and increasing building costs; capital projects will place a greater strain on budgets. Beyond the direct impact of rising rates, the Fed’s actions are driving the U.S. economy in the direction of a recession. During the euphoria of 2021, we shook our heads as we watched many deals for questionable credits or projects come to market at even more questionable yields. Now, issuers and investors will likely face a more difficult credit environment, one that will punish undisciplined approaches. The last downturn was quickly reversed by enormous federal support, but that will not likely be the case this time. The prior monetary and fiscal stimulus only served as a band aid, covering up issues that can only be solved through reform. We have witnessed no such reforms and were incredulous when the rating agencies handed out many upgrades to weak issuers. This is yet another reminder of the importance of independent credit research.

Municipal credits have not had to face conditions like these for 40 years, but they are no strangers to hard times. During the GFC, we witnessed most states and local governments adjust to their new economic reality by making the tough decisions to cut spending and deleverage. As credit conditions tighten and the weight of the Fed’s inflation fight slows down economic activity, we expect greater differentiation in credit pricing. We began to see some of this emerge during the second quarter with Single-A and Triple-B rated securities underperforming high-grades by 100 and 200 basis points, respectively. We remain focused on durable credits that can control their own destiny and protect their market access. Owning these credits helps preserve our clients’ capital and allows us to take advantage of opportunities in choppy markets.

Higher yields, wider spreads, and rampant forced selling have generated widespread opportunities. In contrast to a subdued 2021, our portfolio activity has picked up meaningfully. Unlike the last couple of years, during which our purchases were concentrated in bonds with non-standard coupon structures, this year we have also identified opportunities in bonds with standard coupons. We added a wide range of credits during the quarter, including airports from Houston, Fort-Lauderdale, and Metropolitan D.C., and a very strong healthcare provider, Atrium. Among our highest spread purchases were two-year MTA floaters at +175 basis points, a five-year put bond from Ohio backed by Duke Energy at +170 basis points, and several four-to-five-year State Housing Authority bonds at +115-135 basis points.

We also added several high-quality, longer positions during the quarter such as Ohio general obligation bonds and Utah appropriation debt to rebalance duration. Most municipal bonds with original maturities greater than 10 years are callable and, as rates have climbed, are less likely to be called prior to maturity. Consequently, the duration of our benchmarks has extended, creating a gap with our portfolios which did not hold as much callable bond exposure. We took advantage of today’s higher yields to add high-quality, longer bonds and reduce this duration gap.

We have invested through many difficult periods throughout our careers. This year has surely presented unique challenges as today’s 40-year high inflation is producing serious repercussions for living standards, economic policy, and financial markets. Unlike the recent past when the Fed was quick to abandon its tightening path in the face of weakening financial markets, there is little doubt that inflation fighting will continue to take precedence above all other considerations. Ironically, the strength of the U.S. economy entering 2022, as well as strong household wealth and income growth, may require the Fed to go further than might otherwise have been the case. To us, this all adds up to more risk on the horizon. Attractive long-term opportunities often arise from short-term volatility. Taking advantage of these opportunities requires patience, selectivity, and a long-term orientation – nothing else matters.


Gregory S. Steier
Porftfolio Manager

Performance As of June 30, 2022
  Total Returns Average Annual Total Returns
  3 Mo.* YTD* 1 Yr. 3 Yr. 5 Yr. 10 Yr. Since
BBH Municipal Fixed Income Composite (Gross of Fees) -1.52% -6.54% -6.31% 0.43% 1.84% 2.34% 3.58%
BBH Municipal Fixed Income Composite (Net of Fees) -1.58% -6.66% -6.55% 0.18% 1.59% 2.09% 3.32%
Bloomberg 1-10 Yr. Municipal Bond Index -0.84% -5.55% -5.39% 0.21% 1.32% 1.79% 3.23%

Sources: BBH & Co. and Bloomberg

* Returns are not annualized.
BBH Municipal Fixed Income inception date is 05/01/2002

Past performance does not guarantee future results.

Representative Account
Top 10 Obligors
As of June 30, 2022
California School District General Obligations 9.4%
State of New Jersey
Philadelphia School District, PA
Texas Municipal Gas Corporation II
State of Maryland
Texas School Bond Guarantee Program 3.0%
Texas Department of Housing and Community Affairs
Texas Municipal Gas Acquisition and Supply Corporation 2.4%
Pre-Refunded or Escrowed to Maturity
Salem-Keizer School District #24J, OR 2.2%


Sources: Bloomberg and BBH Analysis

1 One “basis point” or “bp” is 1/100th of a percent (0.01% or 0.0001).


There is no assurance that a portfolio will achieve its investment objective or that the strategy will work under all market conditions. The value of the portfolio can be affected by changes in interest rates, general market conditions and other political, social and economic developments. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, maturity, call and inflation risk; investments may be worth more or less than the original cost when redeemed.

Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax.

The Strategy also invests in derivative instruments, investments whose values depend on the performance of the underlying security, assets, interest rate, index or currency and entail potentially higher volatility and risk of loss compared to traditional stock or bond investments.

As the Strategy’s exposure in any one municipal revenue sector backed by revenues from similar types of projects increases, the Strategy will become more sensitive to adverse economic, business or political developments relevant to these projects.

The Representative Account is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the strategy.

The objective of our Municipal Fixed Income Strategy is to deliver excellent after-tax returns in excess of industry benchmarks through market cycles. The Composite includes all fully discretionary fee-paying municipal fixed income accounts with an initial investment equal to or greater than $5 million that are managed to an average duration of approximately 4.5 years. Portfolios that subsequently fall below $4.5 million are excluded from the Composite.

Bloomberg 1-10 Year Municipal Bond Index is a component of the Bloomberg Municipal Bond index, including bonds with maturity dates between one and 17 years. The Bloomberg Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year. One cannot invest directly in an index.

“Bloomberg®” and the Bloomberg 1-10 Year Municipal Bond Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Brown Brothers Harriman & Co (BBH). Bloomberg is not affiliated with BBH, and Bloomberg does not approve, endorse, review, or recommend the BBH Strategy. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the fund.

Brown Brothers Harriman Investment Management (“IM”), a division of Brown Brothers Harriman & Co (“BBH”), claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

To receive additional information regarding IM, including a GIPS Composite Report for the strategy, contact John Ackler at 212 493-8247 or via email at

Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. “Net” of fees performance results reflect the deduction of the maximum investment advisory fees. Returns include all dividends and interest, other income, realized and unrealized gain, are net of all brokerage commissions, execution costs, and without provision for federal or state income taxes. Results will vary among client accounts. Performance calculated in U.S. dollars.

Holdings are subject to change.

Credits: Obligations such as bonds, notes, loans, leases and other forms of indebtedness, except for Cash and Cash Equivalents, issued by obligors other than the U.S. Government and its agencies, totaled at the level of the ultimate obligor or guarantor of the Obligation.

Issuers with credit ratings of AA or better are considered to be of high credit quality, with little risk of issuer failure. Issuers with credit ratings of BBB or better are considered to be of good credit quality, with adequate capacity to meet financial commitments. Issuers with credit ratings below BBB are considered speculative in nature and are vulnerable to the possibility of issuer failure or business interruption.

Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities, are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2022. All rights reserved.

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IM-11349-2022-07-15    Exp. Date 10/31/2022

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